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Regulation of Credit Rating Agencies (CRAs) in India rising debt levels of IL&FS, and continued maintaining the rating assigned to IL&FS as AAA, indicating the highest level of creditworthiness. Introduction and Governance Following the default of IL&FS and its subsidiaries, contagion effect was witnessed in the entire NBFC space that led to an impairment in the Credit Rating Agencies (CRAs) assess creditworthiness of organizations demand for such issuers. This led to a sharp plunge in their share prices and rate their credit risk by analyzing their financial performance, level and discounted trade levels of their issuances, calling for heightened and type of debt, lending and borrowing history, ability to repay the debt, stringency in the norms followed by credit rating agencies to assess and the past debts of the entity into consideration. In India, CRAs are creditworthiness of the issuers. regulated as per the SEBI (Credit Rating Agencies) Regulations, 1999 which provide for eligibility criteria for registration of credit rating SEBI regulations on CRA’s | Proposed Changes agencies, monitoring and review of ratings, requirements for a proper rating process, avoidance of conflict of interest and inspection of rating In order to strengthen the regulatory practices governing CRA’s, SEBI has agencies by SEBI, amongst other matters. However, certain other issued the following detailed guidelines: regulatory agencies, such as the Reserve Bank of India (RBI), Insurance Regulatory and Development Authority (IRDA), and Pension Fund • Hike in the minimum net worth threshold for the rating agencies to INR Regulatory and Development Authority (PFRDA) also regulate certain 25 crore from the current level of INR 5 crore. (30th May, 2018) aspects of credit rating agencies under their respective sectoral • Denial of direct or indirect shareholding by a CRA of over 10% in jurisdiction. another CRA. • Mandatory disclosures in the ‘Analytical Approach’ section (13th Nov, The SEBI (Credit Rating Agencies) Regulations, 1999 were designed to 2018) to be made as given below: ensure that only reliable players enter this domain through stringent o Any expectation of support from Parent/Government shall be eligibility criteria. Currently, there are seven CRAs registered with SEBI sufficiently substantiated with a detailed rationale for timely including CRISIL Limited, India Ratings & Research Pvt. Ltd, ICRA infusion of funds by the parent entity Limited, Credit Analysis & Research Ltd, Brickwork Ratings India Pvt. Ltd, o When all subsidiaries/group companies are factored in to arrive at SMERA Ratings Limited and Infomerics Valuation and Rating Pvt. Ltd. a rating, list of all the companies along with rationale for strength derived from such entities shall be provided. Need for Regulatory Amendments • Inclusion of a separate section on ‘Liquidity’ in the press release comprising the below mentioned parameters (13th Nov, 2018): Credit rating agencies faced criticism of the investors for delay in o Liquid investments or cash balances, access to unutilized detecting stress in the Infrastructure Leasing and Financial Services credit lines Limited (IL&FS) group, a major infrastructure development and finance o Liquidity coverage ratio, debt servicing ability for company of systemic importance with a debt obligation of INR 91,000 maturing obligations crore, which defaulted on its outstanding credit liability from banks, • Review of rating criteria in the following (13th Nov, 2018): mutual funds and provident funds. The credit rating agencies ignored the

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o Assessment of subsidiaries in terms of the inter linkages and long-term associations between the issuer and the credit rating liquidity conditions of the holding company. agency, along with compulsory rating of more than one agency in o Review of liquidity conditions and asset liability mismatch of respect of debt instruments or bank credit of more than INR 100 entities while monitoring their repayment schedules. crore. o Review of sharp deviations in the spreads of debt instruments Comparison of Indian rating Framework with the International over the benchmark yield and disclosure of the same as a Rating framework – Study by CRISIL reflection of a material event. • CRA’s to disclose their average one year transition rate over a 5 year As India’s sovereign rating of BBB serves as a ceiling for evaluating the period for investors to understand the historical performance of rating credit worthiness of Indian Corporates on the global scale, the 32,500 agencies and evaluate the performance of CRAs on the stability of ratings rated companies would be rated on a range of BBB to D instead of AAA assigned. (13th Nov, 2018) to D.

40000 Distribution of all Credit Ratings in India The above mentioned directives aim at making ratings congruent to 32534 market developments, directing them to follow a forward-looking and proactive approach for identifying threats and concerns, whilst reducing 20000 14328 their dependence on historical data. 6792 7853 Further, making the information of ratings transitions by CRAs available 276 1159 2725 160 2131 to investors helps them to get a perspective on the due diligence followed 0 by a CRA before rating allotment. It also enables the investors to AAA AA A BBB BB B C D Total evaluate the stability of CRAs in events of distress, which is sacrosanct Number of Issuers their long-term integrity, reliability and performance. Source: Indian Credit Rating Agency Websites as of January 2019

Current Regulatory Developments Companies rated AAA on the domestic rating scale comprise 0.82% of the total issuances in India against only two AAA rated US companies as The Standing Committee on Finance submitted its report on per the global rating scale, accounting for less than 0.00% of the overall ‘Strengthening of the Credit Rating Framework in the country’ issuances. The disparity occurs as certain country specific parameters on February 13, 2019, highlighting the following observations on the used for analyzing the credit profile of different countries on global scale working of the CRA’s- stand excluded for intra-country analysis as they uniformly impact the entities operating in a country.  The Committee suggested to shift from ‘issuer pays model’ under which the entity issuing the financial instrument pays the Way Forward agency upfront to rate the underlying securities, leading to conflict of interest to ‘investor pays model’ or ‘regulator pays In light of the series of instances including the failure of CRAs to identify model’. the financial trouble developing from the IL&FS crisis and the dubious  The Committee recommended that mandatory rotation of rating debt securities based on subprime housing loans, there lies an impending agencies should be explored to avoid negative consequences of need to heighten the stringency of the norms followed by these agencies Nine Decades of Excellence in Broking and Investment Banking

that bear the responsibility of cultivating a reliable debt model. It therefore remains imperative for CRAs to adopt a transparent framework that focuses on subjective and qualitative factors such as management risk appetite.

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